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Is Your Market Crash Plan Ready?

A big drop isn't necessarily imminent, but it's always good to be prepared.

The stock market continued to climb Tuesday, as nervousness about the beginning of earnings season later this week could not quell overall enthusiasm about the health of the U.S. economy. As of 10:55 a.m. EDT, the Dow Jones Industrials (DJINDICES:^DJI) were up 84 points, and other major market benchmarks climbed roughly between a quarter percent and a half percent. Yet with the bull market more than 6 years old, a rising number of investors are looking at the potential for doom and gloom. That doesn't mean a market crash is definitely going to happen anytime soon, but it does emphasize the need to have a plan in place that will guide your behavior when the markets start to drop.

Why short-term traders are worriedBearish investors have discussed a number of near-term concerns for a while now. Total earnings for the S&P 500 in this reporting season appear due for year-over-year declines for the first time since the middle of 2009, with plunging earnings in the energy industry accounting for much but not all of the overall drop. Some analysts expect the headwinds from energy and other factors to persist throughout the year, which would make 2015 the first year of contracting earnings since immediately after the financial crisis. That threat has been called an "earnings recession" and could be one catalyst toward a long-awaited correction in stock market indexes.

Increasingly, market participants are pointing to macroeconomic forces that could end the favorable trends that have supported stocks in recent years. After years of easy monetary policy, the Federal Reserve is likely to raise rates in the near future; while many aren't certain whether that will happen in 2015, the looming threat nevertheless has been enough to discourage some from investing in rate-sensitive opportunities. The U.S. dollar's gains against most foreign currencies continue to weigh on corporate earnings for U.S. multinationals, further exacerbating the hit to growth and spreading it well beyond the energy sector. Internationally, Europe and Japan are both experiencing substantial economic weakness, and central-bank efforts have been mixed successes thus far.

Source: Wikimedia Commons, courtesy wikiuser100000.

How to planThe most important element of a crash plan is having it in place before stocks start to fall. Once a big decline sets in, you can count on emotions to wreak havoc on your ability to think through the right investing decisions rationally.

If you haven't looked at the asset allocation in your investment portfolio for a while, now's the right time to see what has been happening. If you're like many people, the rise in the stock market has left you with a higher than usual percentage of your assets in stocks, and that could have raised your risk beyond levels that are acceptable to you. Rebalancing to take profits in winning investments while boosting the amount of more conservative investments could make you more comfortable with a downturn when it comes.

The other major way to build a crash plan is to take a good look at the individual stocks you own to make sure they can survive tougher business conditions. Often, even shares of weaker companies rise in a bull market, as the positive influence of the market tends to lift share prices overall. Only when the good times end does it become evident that some companies are stronger than others, and share-price declines in a crash usually reward those who pick healthier companies and punish those who own speculative plays.

Again, a crash could come tomorrow, but it could also be years away. Eventually, though, downturns will happen, and having a smart plan in place is the best way to ensure you'll be able to handle the financial fallout when the bull market comes to at least a temporary end.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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